Virtual communities have proliferated in recent years – a phenomenon triggered by technological developments and by the increased use of the internet. In some cases, these communities have
created and circulated their own currency for exchanging the goods and services they offer, and thereby provide a medium of exchange and a unit of account for that particular virtual community.

This paper aims to provide some clarity on virtual currencies and tries to address the issue in a structured approach. It is important to take into account that these currencies both resemble money and necessarily come with their own dedicated retail payment systems; these two aspects are covered by the term “virtual currency scheme”. Virtual currency schemes are relevant in several areas of the financial system and are therefore of interest to central banks. This, among other things, explains the ECB’s interest in carrying out an analysis, especially in view of its role as a catalyst for payment systems and its oversight role.

This report begins by defining and classifying virtual currency schemes based on observed characteristics; these might change in future, which could affect the current definition. A virtual
currency can be defined as a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community. Depending on their interaction with traditional, “real” money and the real economy, virtual currency schemes can be classified into three types: Type 1, which is used to refer to closed virtual currency schemes, basically used in an online game; Type 2 virtual currency schemes have a unidirectional flow (usually an inflow), i.e. there is a conversion rate for purchasing the virtual currency, which can subsequently be used to buy virtual goods and services, but exceptionally also to buy real goods and services; and Type 3 virtual currency schemes have bidirectional flows, i.e. the virtual currency in this respect acts like any other convertible currency, with two exchange rates (buy and sell), which can subsequently be used to buy virtual goods and services, but also to purchase real goods and services.

Virtual currency schemes differ from electronic money schemes insofar as the currency being used as the unit of account has no physical counterpart with legal tender status. The absence of a
distinct legal framework leads to other important differences as well. Firstly, traditional financial actors, including central banks, are not involved. The issuer of the currency and scheme owner is usually a non-financial private company. This implies that typical financial sector regulation and supervision arrangements are not applicable. Secondly, the link between virtual currency and traditional currency (i.e. currency with a legal tender status) is not regulated by law, which might be problematic or costly when redeeming funds, if this is even permitted. Lastly, the fact that the currency is denominated differently (i.e. not euro, US dollar, etc.) means that complete control of the virtual currency is given to its issuer, who governs the scheme and manages the supply of money at will.